Why closing a credit card can damage your credit

Miffed at an annual fee, a consumer closes a card -- and his score plummets

Dear Credit Score Report,
I recently closed my Chase Marriott Rewards card after they increased the annual fee by over 40 percent from $60 to $85. On principle, I chose to cancel the card. I have excellent credit. I pay my bill off every month, with the occasional balance carried over a month or two with a large purchase. The credit limit on my card was $18,000. I had another card that I still have that has a limit of $19,500. When I closed my Chase Marriott card, my credit dropped by almost 40 points, from 774 to 735. I understand that companies can charge a fee for their products, but it seems unreasonable that decreasing my amount of available credit when I do not generally carry a balance would drop my credit score by 40 points. What is your take on this? Thanks. -- Andy

Hey Andy,
It's unfortunate that a careful borrower such as yourself would see his credit score fall, but based on the way your score is calculated, it makes sense.

You probably know that closing a credit card can alter a key ratio used in the calculation of your credit score: the debt-to-limit -- or utilization --ratio. As its name implies, that ratio is a comparison between your outstanding debt and your available lines of credit. "Generally, the lower the credit utilization percentage, the better it is for the FICO score," says Barry Paperno, consumer operations manager at myFICO.com. If, however, you have lots of debt with very little available credit left over, your ratio signals that you are in danger of maxing out accounts -- and your score falls. Unfortunately, the scoring model doesn't know that you closed that Chase account in reaction to a higher annual fee. All it sees is a credit limit that declined from $37,500 ($19,500 plus $18,000) to $19,500. And it penalizes you in response.

So what about all those months when you pay your balance in full? As I've previously described in a column, lenders typically report your debts to the credit bureaus once per month, including whatever balance was listed on your most recent statement. That means even if you pay that balance in full after the statement is issued, the bureaus will still note the latest card balance on your credit reports. In other words, paying your debt in full doesn't mean a zero balance will appear on your credit reports.

You can take action. To keep larger balances from appearing on your credit reports, make payments to the bank more than once a month. For example, rather than letting a $1,000 balance accumulate over the course of a month and then appear on your statement, make a payment of $500 halfway into the month and then another $500 payment at month's end. (That, of course, is assuming you have the cash during the month to make the payments.) Alternately, you may want to consider putting fewer expenses on your plastic, if preserving your credit score is a high priority.

What else can you do? See if your other card issuer will grant a request to increase your remaining line of credit to make up for a portion of that closed account. Meanwhile, look for any errors on your credit reports and dispute them.

But even though I urge consumers to improve their credit whenever possible, there are times when you just don't need to be too concerned. FICO scores, which are the most popular credit scores in the United States, range from 300 to 850. With a credit score in the mid-700s, you're still doing quite well. And if you don't have any plans to apply for a loan in the short term, there's little reason to worry about a score drop of about 40 points. (Of course, if you know a lower score will hurt an upcoming loan application, you may want to wait for your score to rebound before applying. Check out the loan tables at myFICO.com for an idea of how different scores impact mortgages, home equity and auto loans.)

As long as you're borrowing responsibly -- paying all bills on time, keeping balances low and only opening new loan accounts only when absolutely necessary -- your credit score will recover from this decline.

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